Goldman Sachs unveiled last Tuesday a new MBS valuation methodology that it claims more accurately assesses MBS - taking into account movements in other markets, such as agency debt and swaps, as well as volatility in underlying benchmarks. The new model went live last Thursday on the firm's external client website.
"The model combines an updated prepayment model with mortgage rate and term structure models to capture the interaction of mortgage valuations with other fixed-income markets in an arbitrage-free manner," the bank said in a prepared statement. The new model is unofficially called the Goldman Mortgage Valuation Model.
Using the new framework, Goldman notes that MBS product is less sensitive to changes in implied volatility than conventional wisdom dictates. Also, Libor OAS and durations give a clearer picture of value and risk since they more fully reflect the factors that drive mortgage pricing Goldman also theorizes that loan seasoning has become a less valuable indicator of future prepayments because the burnout factor of borrowers has become less pronounced.
Goldman derives new valuations for the mortgage market starting with an updated prepayment model, described as a multi-population model that emphasizes the direct but diverse responses of mortgages to rate incentives and to the aging of particular vintages of loans. Goldman has decreased its reliance on the "burnout factor" and increased the slope of the S-curve, meaning faster prepayments across the board.
The new term structure is an arbitrage pricing model calibrated to swap rates instead of Treasury yields, which is tailored to fit the volatility of swaptions of various tenors and strikes. The term structure takes into account the value of options that are both in and out of the money, something that is not accounted for in competing models, Goldman claims.
Mortgage rates are modeled using a constant option adjusted spread approach, designed to capture the impact of changes in implied volatility and the shape of the yield curve on mortgage yields. The result is the belief that IOs, POs and premium passthroughs are short optionality, or less sensitive to volatility than previously thought.
"Our prepayment model had run off course in a number of coupons owing to a combination of dramatic changes in prepayment behavior with the insufficient robustness of the model's self-adjustment mechanism," says report author Jeremy Primer in the inaugural report. "It was due for a full re-estimation and some fixes to the monthly self-adjustment procedure."
Primer notes that, using the previous model, the slope of the S-curve had a maximum increase of 10-12 CPR for a 50 basis point rally in rates. Using the new model, Goldman estimates increases of up to 20 CPR per 50 basis point rally in mortgage rates. While long-term speeds for lower coupons (Ginnies and conventionals) are substantially faster in a rally, Goldman also found that high premiums experience only modest increases in prepayments during a rally.